Plan to bar funds from commodities garners few fans

Of Lieberman's three proposals, most extreme finds fewest adherents

By

LauraMandaro

SAN FRANCISCO (MarketWatch) - A proposal to ban large pension funds and other institutional funds from commodities trading was sharply criticized Tuesday, with a U.S. senator who is working on legislation to curtail energy speculation also arguing against the ban.

"While I believe that the influx of money by pension funds" and other financial investors "has had a detrimental impact on prices, prohibiting investments risks harming future and current retirees," said Sen. Susan Collins, R-Maine, at a hearing before the Senate's committee for homeland security and government affairs, which was Web cast.

The proposal is one of three legislative fixes floated by Sen. Joseph Lieberman, an independent from Connecticut, last week. Lieberman and Collins are working together on legislation to curb excessive speculation in the commodities market. Lieberman said they hope to introduce a bill "after the fourth of July recess." See earlier story.

At Tuesday's hearing on the three proposals, Collins said she differed from her colleague on the attractiveness of the most extreme fix. It would prohibit private and public pension funds with more than $500 million in assets from investing in agricultural and energy commodities traded on a U.S. futures exchange, foreign exchange or over the counter.

"An outright ban would have unintended consequences for retirees," she warned.

The chairman of a group that represents 110 of the country's largest pension fund also warned that such a proposal could harm Americans' retirement holdings.

"We firmly believe that commodities may be part of a prudent, well-diversified investment portfolio by providing a hedge against inflation and minimizing volatility," said William Quinn, chairman of the Committee on the Investment of Employee Benefit Assets (CIEBA).

He noted that defined benefit plans surveyed by CIEBA, whose members manage more than $1.5 trillion of defined benefit and defined-contribution plan assets, show the plans have less than 1% of their assets invested directly in commodities. But what they have is key to their performance, he said.

"Regulating pension investments would make it difficult for pension plans to adequately diversify investments to hedge against market volatility and inflation," Quinn said in prepared remarks.

Similarly, James Angel, a Georgetown University professor who teaches courses on derivatives, warned of "many problems with this proposal." These include the risk that restricting investments in commodities may cause them to "experience higher volatility and potentially lower returns" and could drive business offshore, where it's harder to monitor.

Support for limits on financial speculation, closing swaps loophole

Instead, several witnesses said they preferred a second proposal that would impose total limits on the share of the commodity market held by financial speculators.

Michael Masters, an equities investment manager who has argued at several Capitol Hill hearings that some types of institutional investors are driving up the price of oil and other commodities, proposed setting up a panel composed exclusively of producers and consumers of every commodity. The panel would set up "reasonable" speculative position limits in the spot months, with approval by the futures regulator, he said.

But such wide-ranging limits would be tough to impose, said the acting chairman of the Commodities Futures Trading and Commission.

"It would be difficult to determine the optimal level," of speculative limits, said the CFTC's Walter Lukken, in answer to a question. "And how would we police it?"

Congressional efforts to place more limits on speculation have intensified as oil prices have flirted with $140 a barrel - despite moves to increase supplies, such as cutting off new contributions to the U.S. Strategic Petroleum Reserve.

Also Tuesday, Sen. Byron Dorgan, D-North Dakota, introduced legislation that would require the CFTC to classify trades as either legitimate hedge trading or non-legitimate hedge trading; increase margin requirements to 25% for non-legitimate trades; and revoke "all prior actions or decisions" that keep the CFTC from discouraging speculative trades.

Dorgan's proposed legislation would also convene a group of regulators to keep petroleum futures safe from excessive speculation.

Rep. John Dingell, D-Michigan, said Monday his office was looking into any legal loopholes that may have contributed to speculation in energy markets.

One exemption under scrutiny by both regulators and lawmakers is what's known as the "swaps loophole."

It effectively gives investment banks such as Goldman Sachs Group, Inc.
GS, +0.17%
and Morgan Stanley
MS, +0.34%
an exemption from limits on speculative futures positions when they buy these contracts as a hedge against their contracts with pension funds and other large investors. Masters and others claim the exemption has allowed pension funds to build large futures positions while avoiding the CFTC's rules on speculation.

Lukken said Tuesday that the CFTC is looking closely at investments in the futures markets that are made via swaps contracts.

"If people are purposely evading speculative limits, through swaps dealers, we'll have concern about and take action against," that activity,'" he said.

Also, in answer to a question by Lieberman, Lukken said Congress has "absolutely" closed the so-called Enron loophole.

Over the weekend, presidential candidate Barack Obama proposed further curbs on this trading exemption that would go further than the ones incorporated in the recently passed U.S. farm bill. See full story.

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